Our glossary below will provide you with an explanation of various financial terms used throughout this Finance Directors Guide to Pensions.


Asset backed contributions (ABCs)

ABCs involve an employer transferring an asset to a special purchase vehicle for a fixed term. A contractual funding arrangement is created under which an income stream is provided to a plan via the special purpose vehicle. That income stream is usually given a net present value by the trustees and is treated as an asset, thereby reducing or eliminating the plan’s deficit.

Bulk Annuity Policy

A policy offered by UK insurers whereby pension plans pay a lump sum in exchange for an annuity that pays the retirement income in respect of some or all of the plan’s members.

Buy-in / Buy-out

A “de-risking” investment decision taken by the trustees of a defined benefit pension plan to match the pension benefits promised to a group of members by purchasing bulk annuity policies with an insurance company. If the policies are held in the Trustees’ name then it is a “Buy-in”; in this scenario the insurer makes regular payments to the pension plan for the pension amounts covered by the bulk annuity policy, but the liability for paying the members’ benefits remains with the trustees and the pension plan. Such a buy-in policy is an asset of the pension plan. If the policies are assigned to the individual members (effectively severing the link with the plan), then it is a “Buy-out”: the liability for these members’ benefits is transferred from the pension plan to the insurer, and the insurer makes the annuity payments directly to the members.

Consolidation vehicle

Pension consolidation vehicles (sometimes referred to as “consolidators” or “superfunds”) for DB plans are a new type of arrangement in the UK that could in due course provide an alternative to a buy-out for companies seeking to settle their UK pension liabilities. Pension plan trustees would be able to transfer part or all of the DB pension plan liabilities to a consolidation vehicle, which would take on full responsibility for those liabilities. The UK Government is currently consulting on the legislative framework for authorisation and supervision of these arrangements.

Deficit contributions

Additional contributions from sponsoring employers, above the ongoing future service contributions, required in order to fund the deficit in respect of a plan’s past service liabilities.

Diversified Growth Fund

Diversified growth funds invest in a wide range of asset classes in order to provide investors with real returns over the medium to long term, whilst limiting the fund’s exposure to market fluctuations (i.e. lower volatility). Investment performance targets are often set as a margin over LIBOR, a benchmark interest rate or an inflation index.

Flexible retirement offer

Flexible retirement offers can include:

  • Retirement transfer options: at retirement plan members are offered a transfer to another pension arrangement instead of drawing a pension from the plan. The transfer would be subject to the member taking independent financial advice, which the company may pay for. This may be of interest to members who wish to take their benefits in a different from to the type of pension provided by the DB plan (e.g. seeking a higher initial pension by removing increases in payment or dependant’s pension) or who wish to take advantage of the DC pension flexibilities.
  • Early retirement exercises: encouraging members to begin drawing their pension early (subject to reduction – although possibly a smaller reduction than would normally apply) in order to accelerate payments out of the plan to reduce its overall size and duration.

Funding level

The relative value of a plan’s assets and liabilities, usually expressed as a percentage (also known as the ‘funding ratio’).

Gradual run-off

In the context of a pension plan, in particular one that is closed to new benefit accrual, continuing to operate the plan and pay benefits from it until the last beneficiary dies.

Liabilities

The estimated value, using actuarial methods and assumptions, placed on the defined benefit obligations (that is, the benefits promised to members) of a pension plan. These defined benefit obligations include the present value of future pension instalments and contingent benefits (for example, benefits paid to family members on the member’s death) and may include the expected value of future expenses.

Liability driven investment (LDI)

An investment management style in which a bond portfolio is built up to better match the plan’s liability profile, either by investing in those bonds directly, or in synthetic bonds created using swaps. The use of swaps allows for the option of “gearing” so that the portfolio is more fully immunised against interest rate and inflation movements, but some of the assets are still available to invest in risk-seeking assets (which then adds risk back in to the portfolio).

Liability management exercise

Liability management exercises are a well-established means of managing down the size of liabilities and risks associated with defined benefit pensions, whilst also offering increased choice to plan members. The main types of liability management exercises are: pension increase exchange (PIE), enhanced transfer values (ETV), retirement transfer offers, early retirement exercises and DB to DC enhanced opt-outs.

Parent company guarantee

Where a company’s subsidiary participates in a DB pension plan, the parent company can provide a guarantee to the pension plan that it will meet some or all of the subsidiary’s financial responsibilities, if the subsidiary cannot meet them itself. Such a guarantee allows the plan trustees to rely on the resources of parent company, thereby improving the security of the plan and in funding negotiations for example, may give the trustees sufficient comfort to agree to lower deficit contributions paid over a longer period than they would otherwise be prepared to accept.

Pension flexibilities (or DC flexibilities)

Following the introduction of the Freedom and Choice legislation for defined contribution (DC) plans in 2015, DC plan members are no longer required to use their DC pension savings to buy an annuity at retirement. They now have the option to take their DC pension savings as single lump sum or as regular withdrawals from the fund.

Pension increase exchange (PIE)

An offer under which a member would give up future (non-statutory) pension increases in exchange for a one-off uplift to their pension.

Transfer value exercise

An offer under which deferred members of a defined benefit plan are reminded of their ability to transfer the value of their benefits into an alternative pension arrangement (such as a defined contribution plan). Plan members are provided with an up-to-date quotation of the transfer value of their benefits in the plan and offered access to independent financial advice. The offer may include an enhancement to the standard transfer value level (known as enhanced transfer value or ETV exercises).

Trivial commutation exercise

Within DB pension plans it is possible to convert the whole of a small pension into a one-off cash lump sum payment to the plan member, subject to certain eligibility criteria. The offer can be made to pensioners and deferred members over the age of 55 years. From the company’s point of view, these exercises can reduce the level of pension liabilities (and therefore risk) as well as reducing future administration costs.


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